Lessons for 2016: Internal borrowing, interest rate risks & revising MRPs

CIPFA’s Mandy Bretherton finds that 2015 taught local government finance that it is more important than ever to understand your balance sheet.

Public sector financial management has been challenging in 2015 and, even after the chancellor’s ‘rabbit out of the hat’ concessions on police and social care funding, it will remain so into 2016.

Ongoing budget restraint and reduction, coupled with increased demand for services, is rapidly becoming the new normal. However, the sector has responded to these challenges.  As a result, 2015 has seen changes in the way that many services are delivered, a trend that is set to continue throughout the coming year.

With the low hanging fruit having been picked, local authorities have been developing new and innovative solutions to delivering services in 2015. This is leading to the development of many different service delivery models, including social enterprises, such as charities that trade, mutuals and community interest companies. New approaches raise practical issues, such as establishing the legal structures, HR issues, procurement and governance. Financing is of course key and it is vital that finance professionals are engaged at the appropriate times.

As we move into 2016, lessons must be learned and shared among those who are developing similar models.  Increasingly, this will help to reduce some of the risks involved and save reinventing the proverbial wheel each time.

Alongside transformation, the devolution agenda has also gathered pace in 2015. Decentralisation will grant local authorities with new powers and potential funding sources. The implications and impact of these new deals on the sector as a whole may begin to emerge in 2016. And CIPFA will be watching closely to assess whether the powers go far enough to make the required difference.

Holding cash & TMS

Accurate, timely and robust financial information on which to base these decisions is more important than ever. However, financial forecasts are becoming increasingly difficult to provide in an environment where future income streams are not clear and pressure mounts on demand-led services.

Effective financial planning encompasses both revenue and capital plans and the linkages between the two. Inherent to this is the need to borrow in order to finance capital investment.

But while interest rates are at an all-time low, there is a high cost for holding cash if the investment is not needed at that point in time.

Therefore in 2015 many authorities have continued to borrow ‘internally’, i.e. using the cash from other areas of the balance sheet in order to avoid borrowing externally.

This means that borrowing can be done when the cash is needed and counterparty risk is limited by reducing investments. This does introduce an exposure to refinancing and interest rate risk, however, which needs to be considered as part of treasury management strategies.

Balance sheets and strategy

Looking ahead to 2016 and beyond, it is more important than ever to understand your balance sheet and how it impacts your financial strategy.

Creating a liability benchmark will allow you to monitor proposed borrowing decisions against cash flows during the year.

One element of this should be the Minimum Revenue Provision (MRP) set aside each year for the repayment of debt.

In 2015 we have seen a number of authorities revising their MRP policies and some have made revenue savings as a consequence.

It is essential however that any revisions to policies are done with due process and with the aim of providing a prudent provision and not the aim of revenue savings.

Where borrowing has been used to finance an asset the provision for its repayment should be over a period for which that asset is expected to provide a service.

In 2015, not only have we seen a focus on the risks associated with the management of debt, we have also seen a change in the risks associated with investments.

Major regulatory changes following the financial crisis are impacting on and indeed introducing new terminology to the risks local authorities are managing.

We’ve seen ’bail-in‘ risk begin to feature in Treasury Management Strategies in response to the new risks posed by European Union directives.

This has lead to an increase in the use of secured deposits such as treasury bills, certificates of deposit and gilt edged securities, a trend that is likely to continue in 2016.

In summary, 2015 has not only seen changes to the way services are delivered it has also seen changes to the associated treasury management risks faced by local authorities.

The one thing that will remain unchanged going into 2016 is the need for strong and effective public financial management especially with the added uncertainties of revenue support grant withdrawal and business rate retention on the horizon.

Mandy Bretherton is technical manager at CIPFA.